Financial Management and Analysis Second Edition THE FRANK J FABOZZI SERIES Fixed Income Securities, Second Edition by Frank J Fabozzi Focus on Value: A Corporate and Investor Guide to Wealth Creation by James L Grant and James A Abate Handbook of Global Fixed Income Calculations by Dragomir Krgin Managing a Corporate Bond Portfolio by Leland E Crabbe and Frank J Fabozzi Real Options and Option-Embedded Securities by William T Moore Capital Budgeting: Theory and Practice by Pamela P Peterson and Frank J Fabozzi The Exchange-Traded Funds Manual by Gary L Gastineau Professional Perspectives on Fixed Income Portfolio Management, Volume edited by Frank J Fabozzi Investing in Emerging Fixed Income Markets edited by Frank J Fabozzi and Efstathia Pilarinu Handbook of Alternative Assets by Mark J P Anson The Exchange-Traded Funds Manual by Gary L Gastineau The Global Money Markets by Frank J Fabozzi, Steven V Mann, and Moorad Choudhry The Handbook of Financial Instruments edited by Frank J Fabozzi Collateralized Debt Obligations: Structures and Analysis by Laurie S Goodman and Frank J Fabozzi Interest Rate, Term Structure, and Valuation Modeling edited by Frank J Fabozzi Investment Performance Measurement by Bruce J Feibel The Handbook of Equity Style Management edited by T Daniel Coggin and Frank J Fabozzi The Theory and Practice of Investment Management edited by Frank J Fabozzi and Harry M Markowitz Foundations of Economic Value Added: Second Edition by James L Grant Financial Management and Analysis Second Edition FRANK J FABOZZI PAMELA P PETERSON John Wiley & Sons, Inc FJF To my wife and children, Francesco, Patricia, and Karly PPP To my children, Ken and Erica Copyright © 2003 by Frank J Fabozzi All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-750-4470, or on the web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201748-6011, fax 201-748-6008, e-mail: permcoordinator@wiley.com Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993, or fax 317-572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley, visit our web site at www.wiley.com ISBN: 0-471-23484-2 Printed in the United States of America 10 Contents Preface About the Authors ix xiii PART ONE Foundations CHAPTER Introduction to Financial Management and Analysis CHAPTER Securities and Markets 27 CHAPTER Financial Institutions and the Cost of Money 49 CHAPTER Introduction to Derivatives 83 CHAPTER Taxation 107 CHAPTER Financial Statements 125 CHAPTER Mathematics of Finance 147 v vi Contents PART TWO The Fundamentals of Valuation 193 CHAPTER Principles of Asset Valuation and Investment Returns 195 CHAPTER Valuation of Securities and Options 211 CHAPTER 10 Risk and Expected Return 257 CHAPTER 11 The Cost of Capital 307 PART THREE Long-Term Investment Decisions 353 CHAPTER 12 Capital Budgeting: Cash Flows 355 CHAPTER 13 Capital Budgeting Techniques 399 CHAPTER 14 Capital Budgeting and Risk 451 PART FOUR Financing Decisions 485 CHAPTER 15 Intermediate and Long-Term Debt 487 CHAPTER 16 Common Stock 533 Contents vii CHAPTER 17 Preferred Stock 571 CHAPTER 18 Capital Structure 583 PART FIVE Managing Working Capital 625 CHAPTER 19 Management of Cash and Marketable Securities 627 CHAPTER 20 Management of Receivables and Inventory 651 CHAPTER 21 Management of Short-Term Financing 679 PART SIX Financial Statement Analysis 719 CHAPTER 22 Financial Ratio Analysis 721 CHAPTER 23 Earnings Analysis 775 CHAPTER 24 Cash Flow Analysis 797 PART SEVEN Selected Topics in Financial Management CHAPTER 25 International Financial Management 821 823 viii Contents CHAPTER 26 Borrowing Via Structured Finance Transactions 861 CHAPTER 27 Equipment Leasing 883 CHAPTER 28 Project Financing 917 CHAPTER 29 Strategy and Financial Planning 933 APPENDIX Black-Scholes Option Pricing Model 975 INDEX 983 Preface Financial Management and Analysis is an introduction to the concepts, tools, and applications of finance The purpose of this textbook is to communicate the fundamentals of financial management and financial analysis This textbook is written in a way that will enable students who are just beginning their study of finance to understand financial decision-making and its role in the decision-making process of the entire firm Throughout the textbook, you’ll see how we view finance We see financial decision-making as an integral part of the firm’s decision-making, not as a separate function Financial decision-making involves coordination among personnel specializing in accounting, marketing, and production aspects of the firm The principles and tools of finance are applicable to all forms and sizes of business enterprises, not only to large corporations Just as there are special problems and opportunities for small family-owned businesses (such as where to obtain financing), there are special problems and opportunities for large corporations (such as agency problems that arise when management of the firm is separated from the firm’s owners) But the fundamentals of financial management are the same regardless of the size or form of the business For example, a dollar today is worth more than a dollar one year from today, whether you are making decisions for a sole proprietorship or a large corporation We view the principles and tools of finance as applicable to firms around the globe, not just to U.S business enterprises While customs and laws may differ among nations, the principles, theories, and tools of financial management not For example, in evaluating whether to buy a particular piece of equipment, you must evaluate what happens to the firm’s future cash flows (How much will they be? When will they occur? How uncertain are they?), whether the firm is located in the United States, Great Britain, or elsewhere In addition, we believe that a strong foundation in finance principles and the related mathematical tools are necessary for you to understand how investing and financing decisions are made But building that foundation need not be strenuous One way that we try to help you build ix Index Financial institutions (Cont.) specialized collateralized borrowing arrangement, 711–713 types, 66–67 Financial intermediaries, role, 54–58 Financial leverage, 584, 723 See also Degree of financial leverage; Wal-Mart Stores ratios, 742–747 relationship See Capital structure; Market risk risk, relationship, 591–594 Financial management, 3–5 See also International financial management interaction See Owner wealth maximization introduction, objective, 12–13 questions, 24–26 Financial markets, access (increase), 843 Financial modeling, 961–966 Financial planning, 933 See also Long-term financial planning budgeting, relationship, 937–961 practices, 966 questions, 967–971 seasonal considerations, 946–948 Financial position, statement, 128 Financial ratio analysis, 721 questions, 765–774 usage, 748–754 Wal-Mart (1996-2001), example, 750 Financial ratios See Wal-Mart Stores usage, 948 Financial reporting purposes, earnings acceleration, 866, 868–871 Financial results, example, 141 Financial risk, 258, 262–265, 467, 743 cost, 335 impact, 558 interaction See Operating risk Financial Services Modernization (FSM) Act of 1999, 60 Financial slack, 619–620 Financial statements, 125 See also Pro forma financial statements filing See Securities and Exchange Commission notes, 143–144 questions, 144–145 Financing See Bank financing; Corporate financing; Institutional financing; Long-term take-out financing; Project financing; Secured financing; Unsecured financing; Individual financing activities cash flow, 140 usage See Cash flow agreement, 928 behavior, 618–619 costs, 801 See also Construction; Inventories flexibility See Business management See Short-term financing obtaining, speed, 892 sources, 811 strategy, 934 subsidiaries, 862 types See Inventories 993 Financing, source, 138 Firm commitment, 62 First in, first out (FIFO), 129, 776 Fitch IBCA, 509, 646, 701, 808, 871 CFAR ratio, 813–814 research reports, 808 Fixed asset turnover ratio, 741 Fixed charge coverage ratio, 745, 746 Fixed costs, 261 Fixed dividends, 573 Fixed exchange rate system, 829 Fixed-rate bonds, 515, 518 floating-rate bonds, contrast, 514–515 Fixed-rate payments, 515, 854 Floaters See Inverse floaters Floating exchange rate system, 829 Floating lien, 708, 709 Floating rates, 488–490, 500 Floating-rate bonds, 518 contrast See Fixed-rate bonds Floats, definition, 641 Floor, 489 agreements, 101–103, 102 motivation, 103 planning, 708 Flotation costs, 314, 327, 560 consideration, 346 inclusion, 320 payment, 319 FOMC See Federal Open Market Committee Ford Motor Company, 670 Forecasted sales, usage, 950 Forecasting See Cash; Sales ability See Analysts regression, usage, 941–945 Forecasts See Analysts; Management error, 943 extrapolative statistical models, 789–792 Foreign commercial banks, 862 Foreign currency, 828–833, 840 relative value, 275 risk, 848 Foreign exchange risk, 852, 923 Foreign market, 837 Foreign tax credit, 835 Form 10-K, 536 Form 10-Q, 536 Forward contracts, 84–89 See also Currency; Longdated forward contracts contrast See Futures contracts Forward market, 831 Forward rates, 73–76 hedgeable rate, 76 Forward start interest rate swap, 523 Foster, Benjamin P., 816 Franks, Julian R., 905 Free cash flow, 560, 805–806 See also Net free cash flow calculation, 807–808 usage, 812 Free trade, advocacy, 826 French, Kenneth R., 794 Frequency distribution, 464–465 Fridson, Martin S., 802, 813 994 FSM See Financial Services Modernization Act of 1999 Full payout leases, operating leases (contrast), 887 Fully amortizing loan, 491 Fundamental factor model, 300–301 Funding costs global market integration, implications, 841 reduction, potential, 866–867 Funding sources, diversification, 866, 867 Funds all-in-cost, 845 opportunity costs, 521, 662 Future cash flows, 357 See also Expected future cash flow; Investment estimation, 474 present value, 224 risk, 416 uncertainty, 400 Future dividends growth rate, 220–221, 340 present value, 322 Future value (FV) annuity factor, 170–173 calculation, 430, 434 determination, 148–155 multiple rates, 154–155 present value, contrast, 185 value, 157 Futures markets, 44 price, 84 trading, mechanics, 84–87 usage See Risk Futures contracts, 84–89, 850 See also Currency contrast See Options forward contracts, contrast, 87 options, difference, 98 risk/return characteristics, 88 FV See Future value GAAP See Generally accepted accounting principles GATT See General Agreement on Tariffs and Trade GDP See Gross domestic product; Gross domestic production General Agreement on Tariffs and Trade (GATT), 826 General commercial partnership, 833 General Electric book value, 136 earnings, 779 General Motors Acceptance Corporation (GMAC), 664, 701 General Motors, class E share (exchange), 538 General obligation bonds, 32 General partnerships, Generally accepted accounting principles (GAAP), 125, 847 Geometric average return, 151, 202–203 Gesellschaft mit beschrankter Haftung (GmbH), 833 Gibson Greetings, losses, 83 GIC See Guaranteed investment contract Glass-Steagall Act, 60, 61 GLB See Gramm-Leach-Bliley Act of 1999 Global banking, 60 Index Global capital market, 839 Global economy, 824–827 Global equity market, 841–844 Global market financing, 837–846 funds (raising), motivation, 839–841 integration, implication See Funding costs GMAC See General Motors Acceptance Corporation GmbH See Gesellschaft mit beschrankter Haftung Gold, Barry, 928 Good faith money, 87 Goods, credit/demand, 656–657 Goodwill, 110 See also Customers definition, 131 Gordon, Myron, 215 Gosh, Chinmoy, 555 Gosman, Martin L., 777 Government interference, 924 Graham, Benjamin, 794 Gramm-Leach-Bliley (GLB) Act of 1999, 60 Grinblatt, Mark, 552 Gross domestic product (GDP), 945 Gross domestic production (GDP), 756 Gross plant/equipment, 131 Gross profit, 136, 748 margin, 736, 738 Gross spread, 62 Growth rate See also Bell Atlantic definition, 150 discussion, 162 Gruber, Martin, 785, 792 Guaranteed investment contract (GIC), 152 Guarantees See Third-party guarantees Guideline lease, 885 Gulf States Utilities, cash problems, 574 Gultekin, M., 785 Half-year convention, 114 Hamada, Robert S., 466, 468 Hara, Lloyd F., 642 Harris, Robert, 792 Harris, Trevor S., 779 Hawkins, Chuck, 936 Hedgeable rates, 76 See also Forward rates Hedging, 831 See also Currency; Interest rates; Long-dated foreign currency exposure Hidden costs, 652 High grade, definition, 70 High quality See Bonds High-risk lending, 922 High-yield bonds, 510 Hirshleifer Company facilities, replacement, 385–389 integrative example See Capital budgeting Historical cost, 126 Historical data analysis, usage, 966 usage, 945 HMFC See Hyundai Motor Finance Company Hodges, Stewart D., 905 Holding cost, 632 Hurdle rate, 469 Hurley, William J., 219 Hyundai Motor Finance Company (HMFC), 664 Index IAS See International Accounting Standards Ibbotson, Roger, 300 I/B/E/S information, 788 IBM Global Financing, 863 manufacturer-lessor, 890 product development/introductions, 945 sales, 944–945 IDRs See International depositary receipts Image-based processing, 644 IMF See International Monetary Fund Implicit costs, 652, 690 Implicit interest, 316 dependence, 317 Import taxes, 107 Income See Interest; Net income bonds, 501 concept See All-inclusive income concept determination See Taxable income statement, 136–138 See also Common size; Pro forma income statement bypassing, 132 taxes, 107, 800 Incorporation, articles, Incremental cash flows, 363–364, 399 Incremental OCF, calculation, 384–385 Indebtedness, 30–32, 488 certificates, 495 Indenture, 244 See also Blanket indenture agreement, 495–496 Independent directors, definition, Independent finance companies, 862 Independent projects, 363 Indifference point See Earnings per share Indirect investments, 54 Indirect method, usage, 800 Indirect quotation, 829 Individual banking, 59 Inflation, impact, 274–275 Information processing cost definition, 57 reduction, 56–57 Initial margin, 86, 87 Initial public offering (IPO), 539, 844 Inside information, definition, 45 Insider directors, definition, Institutional banking, 59–60 Intangible assets, 131 Intercompany transactions, 836–837 Interest See Add-on interest; Deferred interest; Discount; Single payment interest cost See Effective interest cost coverage ratio, 744–746 deductibility, capital structure (relationship), 598– 600 expected risk free rate, 341 expense, 801, 835–836 income, 800 payments, 249, 267, 497–501 tax deductibility, 405, 613 tax shield, 600–602 See also Present value of the interest tax shield distress cost, theory/practice reconciliation, 616– 618 995 taxability, 72 value, 242 Interest on accumulated interest, 149 Interest on interest, 149 Interest rates, 452, 489–490 See also After-tax interest rate; Base interest rate; Nominal interest rate; Periodic interest rate calculation, 67, 183–187 contrast See Effective interest rates costs (hedging), financial derivatives (usage), 521–523 determinants, 68 determination, 162–163 reset formula, 488 risk, 258, 271–273, 646 structure, 68–78 swaps, 99, 516 See also Forward start interest rate swap term structure, 71–79 yields, interactions, 67–68 Interest-earning asset, usage, 91 Interest-free loan, 653 Interest-only loan, 491 Interest-only strip, 868–870, 879 Intermediate debt, 487 questions, 528–532 Intermediate-term debt, 892 Internal credit enhancement, 874 Internal market, 837 Internal rate of return (IRR), 202, 308, 400, 420– 429 See also Investment; Modified internal rate of return; Multiple IRR capital rationing, 426–427 consideration See Cash flow; Cash flow riskiness; Cash flow timing consistency See Owner wealth maximization decision rule, 423–427 evaluation technique, 427–428 explanation, 911 method, 441, 469 mutually exclusive projects, 424–426 program, 911 representation, 422 testing, 423 Internal return objectives, meeting, 926 Internal Revenue Code (IRC), 108, 119–120, 900 Section 163, 598 Section 172, 604 Internal Revenue Service (IRS), 108, 114, 501, 900 requirements, 891 Revenue Ruling 55-540, 901 Revenue Rulings, 902 Internally generated funds, 618 International Accounting Standards (IAS), 847 International depositary receipts (IDRs), 843–844 International financial management, 823 questions, 857–860 International market, 839 International Monetary Fund (IMF), 826 In-the-money option, 246 Intrinsic value, 95 See also Options Inventories, 129, 375, 708–710 associated costs, 665–666 change, 957 996 Inventories (Cont.) cost, 666 days, number, 671–672, 730, 733 financing cost, 709–710 types, 708–709 holding costs, 665 reasons, 664–665 management, 849 model See Just-In-Time Inventory Model reordering cost, 669 shortage, 667 turnover calculation, 749 ratio, 671, 739, 741 Inventories management, 651, 664–672, 739 models, 666–671 consideration, 670–671 monitoring, 671–672 questions, 673–678 Inverse floaters, 500 Investing activities, usage See Cash flow Investment See Capital; Long-term investment; Reinvestment; Short-term investment activities, 800 bankers, definition, 61 banking, 61–64 cash flow, 201, 364–366, 387–389 change, 411 differences, 415 cash inflow, present value, 410 companies, 66 See also Closed-end investment companies; Open-end investment companies cost, 203 decisions, 195, 357–358 definition, 131 determination See Cash future cash flow, 412 IRR, 421 needs, 934 opportunities, 270, 357, 474 payback period, 404 present value, 164, 197–199 problems, 356–358 profiles, 414–415 projects, classification, 360–363 dependence classification, 362–363 screening/selection, 359 strategy, 933 value, 282 yield, 421 Investment returns, 195, 201–207, 222 even cash flows, usage, 203–204 no intermediate cash flows, usage, 201–203 questions, 208–210 uneven cash flows, usage, 204–205 Investment tax credit (ITC), 118–119 Investment-grade bonds, 70, 510 See also Noninvestment-grade bonds IPO See Initial public offering IRC See Internal Revenue Code IRR See Internal rate of return IRS See Internal Revenue Service Index Issued shares, 535 Issuers costs, understanding, 78–79 definition, 61 perceived creditworthiness, 70 Issues expected liquidity, 72 underwriting, traditional process See New issues ITC See Investment tax credit Japanese Ministry of Finance, 838 J.C Penney, 754, 763 Jensen, Michael, 608, 805 JIT See Just-In-Time Job Creation and Worker Assistance Act of 2002, 114 Joint venture, definition, 11 Jointly owned projects, reasons, 920 Jones, Charles P., 777 Jones, Frank J., 300 Junk bonds, 510 Just-In-Time (JIT) Inventory Model, 669–670 Keefe, Victoria, 840 KG See Kommanditgesellschaft KGaA See Kommanditgellschaft auf Aktien Kmart, 754, 763, 935 Kommanditgellschaft auf Aktien (KGaA), 833 Kommanditgesellschaft (KG), 833 Kwatinetz, Michael, 899 Largay III, J.A., 815 Last in, first out (LIFO), 129, 776 Latané, Henry A., 777 Law of one price, 831 Lead time, 668 Leased asset, fair market value, 897 Leases See Net leases; Non-tax-oriented leases; Synthetic leases; Tax-oriented true leases accounting See Capital leases; Operating leases borrow-to-buy decision, comparison, 903–912 brokers, 894 classification, 896 comparison See Alternative leases contract, 912 contrast See Full payout leases; Single-investor leases definition, 133 equivalent loan, 908 expenses, 737 payments See Minimum lease payments; Periodic lease payments; Tailor-made lease payments reduction, 885 programs, 894–895 qualifications, 901 term, 900 transactions See True lease transactions lessees, financial reporting, 895–900 types See Equipment valuation, 903–912 approach, 911–912 model See Net present value Leasing See Captive leasing companies See Specialized leasing companies costs, 888–889 Index Leasing (Cont.) direct cash flow, 903–907 valuation, 907–908 process, explanation, 883–884 reasons, 888–893 Lender definition, 30 relationship See Risk Lessees, 883 financial reporting See Leases Lessors, 883 types, 893–894 Letter of credit, 697 Level payment, 490 Leverage See Degree of financial leverage; Degree of operating leverage effect, 591–592 quantification, 592–594 Leveraged leases, 886–887 contrast See Single-investor leases Liabilities, 128, 132–134 See also Current liabilities; Deferred taxes; Long-term liabilities LIBOR See London Interbank Offered Rate Life insurance companies, 67 LIFO See Last in, first out Limited liability, 535 impact, 612 role, 606–609 Limited liability company (LLC), 10, 833 formation, Limited partnerships, 7, 833 See also Master limited partnership Line of credit See Credit Liquid assets, 729 Liquidation value, 572 See also Preferred stock Liquidity, 729–736 See also Issues; Wal-Mart Stores measures, 733–735 ratios, 735–736, 815 risk, 646 theory, 77–78 Listed stocks, 38 See also Dually listed stocks LLC See Limited liability company Loan amortization, 174 amount, 698 definition, 488 origination fee, 688 payments, determination, 908 Local taxes, 120–121 Lockboxes advances, 644–645 networks, 644 system, 641, 643–644 See also Nonbank lockbox systems Logue, Dennis E., 543 London Interbank Offered Rate (LIBOR), 99, 102, 489–490 LIBOR-based financing, 854 one-year, 100 quoted rates, 695 six-month, 516–518 usage, 500 London Stock Exchange, 842 997 Long call position, 92 Long futures, 88 Long position, 88 Long put position, 93 Long-dated foreign currency exposure, hedging, 850 Long-dated forward contracts, 851 Longer-term borrowing, 891 Long-run planning, 938 Long-term contract, 274 Long-term debt, 336, 487, 617, 747, 926 change, 957 covenants, inclusion, 958 current portion, 132 questions, 528–532 reliance, 763 Long-term debt securities, valuation, 226–245 Long-term financial planning, 961 Long-term indebtedness, 132 Long-term investment, 360 Long-term liabilities, 133 Long-term planning, 938 Long-term prepaid expenses, 131–132 Long-term take-out financing, 922 Long-term trends, projection, 945 Long-term U.S Treasury bond, yield, 469 Lookback currency option, 855 Lublin, Joann S., 20 M1, components, 51 M2, components, 51 M3, components, 51 Maastricht Treaty, 826, 832 Macroeconomic factor model, 300 MACRS See Modified accelerated cost recovery system Mail interception, 644 Maintenance margin, 86 Maintenance problems, elimination See Equipment leasing Malatesta, Paul H., 545 Malkiel, Burton, 789 Managed floating exchange rate system, 829 Management character, 510 forecasts, 946 performance, evaluation, 935 personnel, 922 Manager motivation, 19–21 Mandated projects, 361 Mandatory convertible preferred stock, 576 Margin See Initial margin; Maintenance margin; Quoted margin; Variation margin requirements, 86–87 Marginal corporate tax rate, 615 Marginal cost See Capital; Equity; Stocks Marginal efficiency See Capital Marginal tax rate, 109, 311, 601, 904 increase, 616 Markel, F Lynn, 389 Market efficiency semi-strong form, 45 strong form, 45 weak form, 45 Market risk, 295, 297, 324 See also Projects 998 Market risk (Cont.) compensation, 470 contrast See Stand-alone risk estimation, 465–466 financial leverage, relationship, 466–468 premium, 295, 325 Market value, 13, 336 See also Common stock; Preferred stock; Shareholders contrast See Book value proportions, usage, 337 Market value added (MVA), 15 Marketability risk, 43 Marketable securities, 129, 375, 627, 645–647 questions, 648–651 risk, relationship, 645–646 types, 646–647 Markets activity, statistical data, 839 competition, degree, 360 conditions, 452 conversion price, 575 equilibrium, 200 financing See Global market indicators See Stocks interaction See Securities line See Capital market line; Security Market Line portfolio, 294 purchases See Open market purchases questions, 47–48 reaction See Stocks securities See Capital market securities; Money segmentation theory, 78 share, 763 surveys, 945–946 Marking a position to market, 86 Marking to market, 86 Markowitz, Harry M., 292, 300 Master leases, 892, 895 Master limited partnership, 10 Masulis, Ronald H., 552, 603 Matching principle, 126 Material adverse change, 702 Mattel, Inc., 679–680 Annual Reports (1991 / 2001), 359 Maturity See Original maturity; Term to maturity; Yield-to-maturity approaching See Bonds date, 497 definition, 28 factoring, 707 intermediation, 55–56 length See Borrowing spread, 71 value, 228, 242, 496 definition, 28 McConville, Daniel J., 814 McNichols, Maureen, 552 Meckling, William H., 608 Merchandise credit, 651 Merchant banking, 61 Mergers, 763 Microsoft Corporation, EPS, 783 Miller, Merton H., 557, 559, 594, 595, 603, 637 Model See Modigliani & Miller Model Index Miller-Orr Model, 632, 637–640 limits, 637–639 Minimum lease payments, 897–899 present value, 897 MIRR See Modified internal rate of return M&M See Modigliani & Miller Model MMDAs See Money market deposit accounts Model Business Corporations Act, Modern Portfolio Theory (MPT), 290–301 Modified accelerated cost recovery system (MACRS), 113–114, 372 usage, 380, 385 Modified internal rate of return (MIRR), 207, 269, 400, 429–436 capital rationing, 439 consideration See Cash flow; Cash flow riskiness; Cash flow timing consistency See Owner wealth maximization decision rule, 434–435 evaluation technique, 435–436 mutually exclusive projects, 438–439 Modigliani & Miller (M&M) Model, 594–595 Modigliani, Franco, 557, 594, 595 Monetary policy, 49 Money See Good faith money cost, 67–79 See also Financial institutions future, 53 supply definition, 51 interaction See Federal Reserve System time value, 219, 245, 400, 416, 469 Money center banks, 38 Money market deposit accounts (MMDAs), 52 Money market instruments definition, 500 usage, 500 Money market securities, 699–705 Money markets, 38 funds, 66 mutual funds, 52 securities, 28–29 Monitoring costs, 560 Monsanto, sweetener division sale, 936 Moody’s Investors Service, 508–509, 646, 701, 871 Mortgage, 501 Motorola, cash flow, 141 Multifactor risk models, 299, 340 Multinational companies, 827 Multinational firms, 827–828 Multiple IRR, 428–429 Multiple rates See Future value Murphy, Mary G., 777 Mutual funds, 66 See also Money markets Mutual savings banks, 58 Mutually exclusive projects, 363, 419 See also Internal rate of return; Modified internal rate of return MVA See Market value added Myers, Stewart C., 471, 619, 903, 907 NAFTA See North American Free Trade Agreement National Association for Security Dealers Automated Quotation (NASDAQ), 540 Index National Conference of Commissioners of Uniform State Laws, Model act, National market, 837 Nationally Recognized Statistical Rating Organizations (NRSROs), 508, 571, 701–702 NCFs See Net cash flows Negotiable CDs, 28–29 Net accounts receivable, 129 Net cash flows (NCFs), 379 Net free cash flow (NFCF), 808–811 Net income, 748, 958 Net interest spread, 868 Net leases, 884 See also Triple net lease Net operating cycle, 630, 733 Net operating loss, 604 carrybacks, 119–120 Net plant assets, 131 Net plant/equipment, 131 Net present value (NPV), 400, 410–412, 904 See also Certainty equivalents; Strategic NPV consideration, 416 See also Cash flow; Cash flow riskiness; Cash flow timing consistency See Owner wealth maximization decision rule, 412–416 evaluation technique, 412–414 lease valuation model, 912 technique, 475, 912 Net profit margin, 727–728, 738 Net working capital, 374, 729 change, 388 Net working capital-to-sales ratio, 734, 735 Nevitt, Peter K., 883, 918, 920, 922–924, 927 New issues, underwriting (traditional process), 61–62 New York Stock Exchange (NYSE), 540, 842, 844 NFCF See Net free cash flow Nike, 946, 947 Nominal interest rate, 183–184 Nominal rate, 682 Nonbank lockbox systems, 644 Non-cash expenses, 808 Noncumulative dividends, contrast See Cumulative dividends Noncumulative preferred stock, 574 Noncurrent assets, 128, 130–132 Nondiversifiable risk, 258, 290 Nondividend-paying stocks, 558 Noninvestment-grade bonds, 70, 510 Nonoperating cash flows, 951 Nonparticipating preferred stock, contrast See Participating preferred stock Nonresident corporations, 121 Non-Rule 144A offerings, 66 Non-tax-oriented leases, 884–885, 888, 913 Nontaxpaying position, 905 Non-traditional maturities, 497 Non-U.S exchange-listed companies, 847 Non-U.S taxation, 121–122 No-par stock, 535 Norsk Data, 842 North American Free Trade Agreement (NAFTA), 826–828 Notes, 495–526 See also Secured notes bonds, distinction, 31 holder, role, 31 999 Notional amount, 98–102 Notional principal amount, 98 NPV See Net present value NRSROs See Nationally Recognized Statistical Rating Organizations NutraSweet Company, 936 NYSE See New York Stock Exchange Observed capital structures, 617–618 Obsolescence, 360 risk, 890–891 elimination, 913 Occupational Health and Safety Agency (OSHA), 362 OCFs See Operating cash flows OEA, Inc., 811–813 OECD See Organization on Economic Cooperation and Development Off-balance sheet, 924 Off-balance sheet SPVs, 928 Offene Handelgellschaft (oHG), 833 Office of Thrift Supervision, 58 Office rent, 737 Offshore leases, 895 Offshore market, 839 oHG See Offene Handelgellschaft Ohlson, James A., 779 Open market operations, 52 Open market purchases, 562 Open-end investment companies, 66 Operating activities, 374 usage See Cash flow Operating cash flows (OCFs), 260, 364, 370–374, 388–389 calculation See Incremental OCF change, calculation, 377–379 reduction, 266 Operating costs See Wal-Mart Stores Operating cycle, 729–733, 735 See also Net operating cycle Operating earnings, 137, 723 taxes, deductions, 810 Operating income, 137 Operating leases, 897 See also Cancelable operating lease accounting, 897 contrast See Full payout leases Operating leverage, 265, 611–612 See also Degree of operating leverage Operating loss carrybacks See Net operating loss Operating profit, 137 margin, 726, 737–738 Operating project See Turn-key operating project Operating risk, 258, 259, 357, 611 financial risk, interaction, 265–267 Operational budgeting, 938 Opportunity cost, 91, 362, 370 See also Cash; Funds Optimal capital budget, 333 Optimal capital structure, 614 Options, 89–98, 576–577 See also At-the-money option; In-the-money option; Real options cash flow characteristics, 211–225 challenges, 476–477 1000 Options (Cont.) contracts See Currency contrast See Exchange-traded options exercising, 246 expiration, 472 futures contracts, contrast, 91 inclusion, 71 intrinsic value, 96–97 markets, 44 premium, 89 price, 89 components, 95–97 purchase See Call options; Put options return characteristics, 91–95 risk characteristics, 91–95 time premium, 97 usage See Risk valuation, 211, 245–250 question, 251–256 writer, 89 writing/selling See Call options; Put options Ordering cost, 665–666 Ordinary annuity, 170, 179 present value, determination, 181 Organization on Economic Cooperation and Development (OECD), 836 Original maturity, definition, 28 Originators, 863 Orr, Daniel, 637 See also Miller-Orr Model OSHA See Occupational Health and Safety Agency Oster, Patrick, 936 Other assets, 128 Other current liabilities, 130 Out-of-pocket costs, 619 Out-of-the-money options, 782 Outside directors, 543 definition, Outstanding shares, 536 Overcollateralization, 875 Over-depreciating, 117 Overnight repo, 711 Over-the-counter (OTC) contract, 99 Over-the-counter (OTC) instrument, 87 Over-the-counter (OTC) markets, 35–36, 40, 90, 855 Over-the-counter (OTC) options, contrast See Exchange-traded options Over-the-road vehicles, tax-oriented TRAC lease, 884 Owner equity, 583 Owner wealth, increase, 413 Owner wealth maximization, 357–358, 420, 661, 936–937 discounted payback consistency, 410 financial management, interaction, 16–17 IRR consistency, 428 MIRR consistency, 436 NPV consistency, 413–414 payback, consistency, 404 PI consistency, 418–420 Palmon, Dan, 899 Par value, 134, 496, 535 See also Bonds; Collateral; Preferred stock definition, 28 Index trading, 318 Participating preferred stock, nonparticipating preferred stock (contrast), 574–575 Partnerships, 7–8 See also General partnerships; Limited partnerships; Master limited partnership Patents, definition, 131 Payables, days (number), 732 Payback consideration See Cash flow; Cash flow riskiness; Cash flow timing consistency See Owner wealth maximization duration See Post-payback duration period, 400, 402–405 See also Discounted payback; Investment decision rule, 403 evaluation technique, 404 Payment date, 546 delinquencies, 873 mechanism definition, 57 providing, 57–58 structure, 873 Payoff period, 402 Payout ratio, 553 P/E See Price-earnings Pecking order, 619 Penny stocks, 40, 552 Pension funds, 66 Percent-of-sales method, 959–960 Perfect market, 557, 595 Performance shares, 19 Periodic interest rate, 154 Periodic lease payments, 903 Periodic payments, 925 Permanent working capital, 679 Perpetual annuity, present value, 178 Perpetual preferred stock, 318, 572 Perpetual warrants, 520 Perpetuity, definition, 177 Personal taxes, capital structure (relationship), 602– 603 Peterson, David, 552, 559 Peterson, Pamela, 552, 559 Pettit, Richardson, 555 P&G See Procter & Gamble Philbrick, D.R., 788 Physical deterioration, 360 PI See Profitability index Pier Imports, losses, 83 Planning process, evaluation, 935 Pohlman, Randolph A., 389 Poison puts, 506 Political hurdles, reduction, 828 Political risk, 848 Portfolio See Diversified portfolio asset standard deviation, 287 weight, 287 definition, 280 diversification, 454 expected return, 298 risk, 258, 290–292 Index Portfolio (Cont.) size, 290–292 standard deviation, 287–288 variance, 287 Position, liquidation, 85 Positive net present value projects, 805 Post-auditing, 935 Post-completion audit, 360 Post-payback duration, 403 Post-retirement, 133 PPP See Purchasing power parity Precautionary balance, 631 Preemptive rights, 542 offering, 65 Preferred dividend arrearages, 574 Preferred equity, cost determination, 318 Preferred habitat theory, 77–78 Preferred stock, 336, 571 See also Auction; Convertible preferred stock; Cumulative preferred stock; Noncumulative preferred stock; Perpetual preferred stock; Remarketed preferred stock call features, 576–577 callability, 576 contrast See Participating preferred stock conversion, 576–577 convertibility, 575–576 corporate use, 578–579 cost, 318–320, 339 cumulative feature, 212 definition, 30 dividends, 211, 776 declaration, 572–575 features, 572–578 liquidation value, 572 market value, 337 origination, 571 packaging features, 578 par value, 572 questions, 580–582 share, value, 225–226 valuation, 225–226 voting rights, 577 Premium See Market risk; Risk receiving See Calls value, 228 Prepaid expenses, 130 Prepayment risk, 258, 270 Present value of the interest tax shield (PVITS), 601–602 Present value (PV), 13, 148, 364, 436 See also Cash flows; Future dividends; Investment; Minimum lease payments annuity factor, 170–173, 422 table, usage, 421 calculation, 182 See also Deposits contrast See Future value determination, 155–162 See also Ordinary annuity projects See Positive net present value projects usage See Perpetual annuity value, 157 Prevalence, 11–12 1001 Price elasticity, 656 Price-earnings (P/E) ratio, 218, 792–795 Primary EPS, 782 Primary markets, 33–35 definition, 35 regulation, 62–647 Prime See Bonds Prime rate, 695 Principal amount, 226–227 definition, 17, 28, 488 payments, 249, 267 repayment See Scheduled principal repayment Principals (owners), 560 Private corporation, 536 Private placement, 33 See also Securities definition, 65 Privately-held corporation, 536 Pro forma balance sheet, 955 Pro forma financial statements, 955, 965 Pro forma income statement, 955 Probability distribution, 279, 955 comparison, 459 specification See Taxation/taxes Procter & Gamble (P&G) capital investment, 807–808 cash flows, 800–802 relationship, 807 depreciation/amortization, 807 fiscal year, 800, 809 income taxes, 810 losses, 83 Production costs, 371 change, 737 efficiency, achievement, 828 Professional corporation, 10 Profit margin See Gross profit; Net profit margin ratios, 736 Profitability See Wal-Mart Stores ratios, 736–739, 815 Profitability index (PI), 400, 416–420 consideration See Cash flow; Cash flow riskiness; Cash flow timing consistency See Owner wealth maximization decision rule, 417 evaluation technique, 417–420 method, 438 Profit/loss (P&L) statement, 136 Progressive tax, 109 Project debt, liability, 925 Project financing, 917 benefits, 927 construction phase, 921 credit exposures, 920–922 definition, 918–919 disincentives, 928 engineering phase, 920, 921 Enron, effect, 928–929 key elements, 922–923 operations, 921 questions, 930–931 risk phases, 920–921 start-up financing, 920, 921 1002 Projected benefit obligation, 133 Projects See Complementary projects; Contingent projects; Expansion; Independent projects; Mandated projects; Replacement projects cash flows, 389 delay, risk, 923 economics, 920 failures, causes, 923–924 finance, 917 market risk measurement, 465–469 required return, 470 risk, 434, 442 assessment, 478–480 measurement, 455–469 stand-alone risk, measurement, 455–465 tracking, 359 Promoters, 918 Property taxes, 896 Property-casualty insurers, 67 Prospectus, analysis, 62–63 Proxy card, 540 fight, 545 statement, 540 Public corporation, 536 definition, Public warehouse loan, 709 Publicly held corporation, definition, Publicly-held corporation, 536 Publicly-traded corporations, 537 Purchase option, absence, 897 Purchases, days (number), 949 Purchasing power parity (PPP), 831–832 variation, 832 Purchasing power risk, 258, 274–275, 646 Pure auction process, 36 Pure expectations theory, 77 Pure-play, usage, 468–469 Put options, 89, 247 definition, 473 purchase, 93–95 writing/selling, 95 Put position See Long put position; Short put position Put provision, 72, 502, 505–506 Putable bond, 249, 505 PV See Present value Qualcomm, 777 Quality spread, 70 Quantum Corporation, Annual Report (1996), 358 Quick ratio, 734 Quoted margin, 488 Railroads, creditors, 571 Range See Cash flow risk definition, 278 Rating See Credit; Debt agencies, 508 considerations See Asset-backed securities assigning, factors, 510–512 systems See Bonds Ratios See Activity ratios; Component percentage ratios; Coverage ratios; Financial leverage; Index Liquidity; Profitability; Return-on-investment ratios analysis, 812–814 See also Financial ratio analysis classification, 721–723 selection/interpretation, 753–754 Real estate investment trust (REIT), 66 Real options, 471–474 example, 474–476 Real options valuation (ROV), 471–472 Realized returns, 235–237 Real-world capital markets, 841 Receivables assignment, 706 averages, 660 management, 651–664 questions, 673–678 Record date, 546 Red herring, 63 Reference rate, 99, 488 Refinancing debt, 615 Refunding See Bond issues Registered bonds, 495 Regression line, 941–943 calculations, 343 usage See Forecasting Regulated entities, 866 Regulation D, 65 Regulatory hurdles, reduction, 828 Regulatory problems, 927 Reinvestment annual percentage, 432–433 assumption, 205–207 plans See Dividend reinvestment plan rate risk, 268–270, 646 risk, 258, 268, 513 REIT See Real estate investment trust Relevant risk, 293 Remarketed preferred stock, 573 Remote disbursement, 642 Rendleman, Richard J., 777 Repatriation, restrictions, 848 Repayment schedule, 490–494 Replacement projects, 361–362 Repo See Repurchases Repurchases See Stocks agreement (repo), 705, 711–713 rate, 711 date, 711 price, 711 Required rate of return (RRR), 213, 221, 225, 453 See also Returns explanation, 357, 405 usage, 315 Required return See Project market risk Research and development (R&D), 474–477 Reserve account, 875 Reserve funds, 876–877 Reserve requirement, 52 Reset date, 488 period, 488 spread See Dividends Index Residual loss, 19 Residual value, 885 Resources access, 828 allocation, 937 Restricted stock grant, 19 Retained earnings, 135–138, 320, 327 Retained funds, 321 Return on assets, 723–724, 727–728 Return on equity, 724 Return on investments, 431 See also Investment returns Return-on-asset ratios, 723–724 Return-on-investment ratios, 723–729 Returns See Bonds; Common stock; Realized returns; Wal-Mart Stores characteristics See Futures contracts; Options covariance, 289 definition, 151 form, 201 internal rate See Internal rate of return objectives, meeting See Internal return objectives rate See Internal rate of return; Modified internal rate of return; Required rate of return ratio, 722 required rate, 219–220 risk, interaction, 275–279 outcomes, standard deviation (usage), 277– 279 Revenue bonds, 32 Revenue Rulings See Internal Revenue Service Revenues, 258 change, 370–371, 377, 384 generation, 136 Reverse stock split, 551 Revolving credit, 696 agreement, 696 Ricardo, David, 935 Ricks, W.E., 788 Rights definition, 248 offering, 542 See also Preemptive rights Risk See Cash flow risk; Interest rates; Purchasing power risk; Reinvestment; Relevant risk assessment See Projects aversion, 199, 280–281 bearing, return/tolerance, 280–281 characteristics See Futures contracts; Options classification, 361–362 compensation, 301 contrast See Stand-alone risk control instruments, 32 explanation, 5, 257, 451–452 hedging See Currency impact, 257–275, 281–292 incorporation See Capital budgeting interaction See Diversification; Returns levels, 478 management futures, usage, 88–89 options, usage, 97–98 measurement See Project market risk; Projects models See Multifactor risk models 1003 neutrality, 281 periods, lenders (relationship), 921–922 phases See Project financing preference, 280 premium, 69–72, 294, 596–598 explanation, 453 representation, 325 questions, 302–306 reduction, diversification (usage), 56 relationship See Capital budgeting; Cash flow; Financial leverage; Marketable securities takers See Equity time value, 219 Risk-adjusted rate, 469–471 Risk-free asset, 293 Risk-free rate See Expected risk-free rate Roll, Richard, 300 Ross, Stephen A., 299 ROV See Real options valuation RRR See Required rate of return Rule 144A offerings, 66 See also Non-Rule 144A offerings Rule 415 registration, 63 Ryngaert, Michael, 545 SA See Societe annonyme Saatchi & Saatchi, 842 Safety stock, 637, 668 Salary, compensation, 19 Sale-and-leaseback transactions, 895 Sales cost, 136 forecasting, 940–946 generation, 136 growth, 944 leases See Conditional sale leases price, changes, 737 risk, 258, 357, 611 volume, changes, 737 Sales to inventory ratio, 739 Salomon Smith Barney, 928 Sampling distribution, 465 Sam’s Clubs, 754 Samson, William D., 815 Santiago, Emmanuel S., 389 SARL See Societe a responsabilitie limitee Savings and loan (S&L) associations, 58 Savings deposit, 52 Scale differences, 438–439 Scenario analysis, 461 Scheduled principal repayment, 491 Schlitz Brewing Company, 937 Scholes, Myron, 472, 559 Scott Paper, 842 SCPA See Societe en commandite par actions SCS See Societe en nom collectif Sears Roebuck and Company, 754, 763, 939–940 Seasonal considerations See Financial planning; Strategy planning SEC See Securities and Exchange Commission Secondary markets, 33–35 definition, 34–35 Secured bonds, 31 Secured debt, 489 1004 Secured financing, 705–710 Secured loan, 690 Secured notes, 31 Securities, 27–29 See also Asset-backed securities; Dilutive securities cash flow characteristics, 211–225 creation See Synthetic fixed-rate security; Synthetic floating-rate security markets, 33–46 definition, 28 interaction, 27 private placement, 65–66 questions, 47–48 valuation, 211 See also Long-term debt securities questions, 251–256 Securities Act of 1933, 62, 65 Securities and Exchange Commission (SEC), 10, 127, 495, 701 financial statements, filing, 537 petition, 544 regulations, 62, 892 Rule 14a-6/14a-7, 540 Securities Exchange Act of 1934, 65, 540 Regulation 14A, 540 Rule 14a-8, 544 Securitization, 32 absence, 871 Security See Bonds Security Market Line (SML), description, 296 Seller/servicer, quality, 871, 873 Semiannual U.S coupon payments, 852 Senior bond classes, 865 Seniority See Bonds level, 710 Senior-subordinate structure, 865, 875–876 Sensitivity analysis, 461–463, 954 usage, 460 Serial debt issue, 496 Servicers See Backup servicer Services, credit/demand, 656–657 Servicing, 863–864 Settlement date, 84–85 Setup charges See Buildings; Equipment Set-up expenditures, 364 Seward, James K., 543 Share price volatility See Common stock Shareholders, 533 available earnings See Common shareholders base, increase, 843 definition, 8, 29 equity, 128 impact See Balance sheet market value, 13 statement, 143 rights plans, 545 wealth maximization, 21, 961 capital, marginal cost, 333 social responsibility, 22–23 Shares See Outstanding shares; Performance shares definition, number, 535–536 See also Treasury stock authorization, 135 issued/outstanding, 135 Index price earnings per share (contrast), 14–15 efficient markets, interaction, 16 repurchase See Targeted share repurchase stated value, 134 Sharpe, William F., 292, 293 Shiller, Robert J., 793 Short call position, 93 Short futures, 88 Short position, 88 Short put position, 95 Short-term basis, 849 Short-term construction lenders, 922 Short-term debt covenants, inclusion, 958 obligation, 487 Short-term financing, 939 actual costs, 710–711 costs, 680–689 management, 679 questions, 714–718 Short-term investment, 360, 954 Short-term loans, 132 Short-term security, 701 Sight draft, 703 Signalling explanation See Dividends Silver, Andrew A., 861 Simple interest, 149, 680 Simulation analysis, 464–465, 954 Single payment interest, 683 Single payment loan, 683, 695 Single-investor leases, 913 leveraged leases, contrast, 886–887 Sinking fund, 503–504, 577–578, 745 call price, 504, 577 payments, 267 provision, 502 requirement, 503 Size effect, 299 Small-ticket retail market, 888 Smith, Kimberly J., 391 SML See Security Market Line Social responsibility See Shareholders Societe a responsabilitie limitee (SARL), 834 Societe annonyme (SA), 834 Societe en commandite par actions (SCPA), 834 Societe en nom collectif (SCS), 834 Software packages, 965 Sole proprietorships, S&P See Standard & Poor’s SPE See Special purpose entity Special purpose entity (SPE), 917 consolidation, 926 Special purpose vehicle (SPV), 864, 867, 917 See also Off-balance sheet SPVs Specialist, definition, 36 Specialized collateralized borrowing arrangement See Financial institutions Specialized leasing companies, 893 Speculative balance, 631 Speculative bonds, 510 Sponsored projects, reasons, 920 Sponsors, 918 Spot rates See U.S Treasury Index Spreadsheet programs, usage, 313 SPV See Special purpose vehicle Staggered board of directors, 541 Stand-alone risk market risk, contrast, 453–454 measurement See Projects Standard & Poor’s (S&P), 509, 646, 871 500 Stock Index, 342, 519, 788 Daily Stock Price Record, 339 P/E, usage, 783 Standard deviation, 457 See also Cash flow risk calculation, 279–280, 288 definition, 278 interaction See Variance interpretation, 465 usage See Returns Standard lease, provisions, 894–895 Standby underwriting arrangement, 64 Start-up period, 924 Start-up phase See Project financing State taxes, 120–121 Stated conversion price, 506 Stated rate, 682 Stated value, 535, 572 See also Common stock; Shares Statement of Financial Accounting Standard (SFAS) No 4, 526 No 52, 847 No 76, 505 No 95, 799 No 109, 111 No 128, 782 Statistical data See Markets Statistical factor model, 300 Statistical measures See Cash flow risk Statistical models, extrapolation See Forecasts Stewart III, G Bennett, 15 Stickney, C.P., 815 Stockbrokers, commission, 223 Stockholders, 533 equity, 128 Stock-out, allowance, 668 Stocks See Classified stocks; Dually listed stocks; Listed stocks; Penny stocks appreciation right, 19 classification, 538–539 distributions, 550–553 market reaction, 552–553 dividends, 550–551 shift, 551 exchanges, 39 grant See Restricted stock grant market indicators, 41–43 option, 19 ownership, 535–538 prices, 779 purchasing right, 542–543 repurchases, 561–565 methods, 561–563 reasons, 563–565 return, sensitivity, 341 schedule, marginal cost, 330 split, 551–552 See also Reverse stock split valuation See Common stock; Preferred stock Stojanovic, Dusan, 702 1005 Straight coupon, 227, 498 bond, 228–234 Straight-line depreciation, 114 Strategic NPV, 472 Strategic plan, 933 Strategy, 935–937 comparative/competitive advantages, 935–936 Strategy planning, 933 questions, 967–971 seasonal considerations, 946–948 Strike price, 89, 246, 473 Structured finance transactions borrowing, 861 questions, 880–881 definition, 861–863 example, 877–879 illustration, 863–865 usage, reasons, 865–871 Structured financing, 861 Structured note, 516 Subordinate bond classes, 865 Subordinated bond, 502 Subscription price, 64 Succursale, 834 Sunk cost, 365 Supervoting shares, 539 Swaps, 98–101 See also Commodity; Currency swaps; Interest rates interpretation, 100–101 rate, 523 spread, 523 Swary, Itzhak, 555 Syndicated bank loan, 30 Synthetic fixed-rate security, creation, 516–518 Synthetic floating-rate security, creation, 516–518 Synthetic leases, 902 Systematic risk, 295 See also Unsystematic risk Tailor-made lease payments, 891 Take-and-pay contract, 925 Take-or-pay contract, 925 Target Stores, 754, 763 Targeted block repurchase, 563 Targeted share repurchase, 563 Tax credit See Distributed profits illustration, 904 Tax expense, deferment, 810 Tax Reform Act of 1986, 604, 834 Taxable income, determination, 835–837 Taxation/taxes, 107, 848 See also Deferred taxes; Local taxes; Non-U.S taxation; Progressive tax; State taxes basis, 366 bracket, 108 capital structure, relationship See Personal taxes change, 371–374 clientele, 559 code, change, 391 considerations, 927 See also Corporate entities credits, 118–119, 364 deductibility See Interest havens, 122, 834 law See U.S taxation law preference explanation See Dividends 1006 Taxation/taxes (Cont.) purposes See Depreciation questions, 122–124 rates See Average tax rate; Corporate income tax rates; Marginal tax rate; U.S federal taxation rates probability distribution, specification, 463 relationship See Capital structure shield, 367 See also Depreciation; Interest; Present value of the interest tax shield; Unused tax shields Tax-oriented leases, 888 See also Non-tax-oriented leases Tax-oriented TRAC lease See Over-the-road vehicles Tax-oriented true leases, 885–887, 900, 913 T-bills See U.S Treasury Technical obsolescence See Equipment Technology See Untested technology access, 828 Temporary working capital, 679 Tender offer, 561–562 Term loans, 489–494 Term repo, 711 Term structure See Interest rates shape, determinants, 76–78 Term to maturity, 70–71, 496–497 Terminal value, 436 Texaco, bankruptcy, 610 Therrien, Lois, 936 Thin capitalization, 836 Third-party credit support, 862 Third-party guarantees, 862, 874–875 Three-day delivery plan, 547 Tiers, 702 Time deposit, 52 Time draft, 703 Time patterns, usage See Cash flow Time premium, 95 See also Options Time to maturity, 245 Time value See Cash flow; Money; Risk Time Warner, offering, 543 Times interest-covered ratio, 744 Timing, 780, 781 Titman, Sheridan, 552 Total asset turnover ratio, 740–741 Total debt-to-assets ratio, 742 Total quality control (TQC), 670 Total risk, 453 Toys ’R Us, 672 TQC See Total quality control Trade credit, 651, 690–695, 763 cost, 690–692 implicit cost, 655–656 Tradeoff theory, 617–618 Tranches, 844, 864 Transactions balance, 631 cost, 633 avoidance, 849 demand, 68 recording, 126 Transfer prices, 836–837 Treasury stock, 135, 536 shares, number, 135 Index Treaty on European Union of 1992, 832 Trigeogis, Lenos, 477 Triple net lease, 884 True lease transactions, federal income tax requirements, 900–902 True return, 152 Trust companies, 66 Trust Indenture Act of 1939, 495 Trust receipts loan, 708 Trustee, definition, 66 Turn-key operating project, 922 Turnover rate, 761 Turnover ratios, 722, 815 See also Accounts receivable; Fixed asset turnover ratio; Inventories; Total asset turnover ratio Umapathy, Srinivasan, 966 Uncertainty, 257 amount, 196 degree, 451–452 Uncommitted line of credit, 696 Underlying asset, value, 472 Underlying for the contract, 84 Underwriter discount, 62 Underwriting See Competitive bidding underwriting arrangement See Standby underwriting arrangement definition, 34 process, variations, 64 service, 54 standards, 863 traditional process See New issues Uneven cash flows, 168–170 Unsecured financing, 689–705 Unsecured loan, 690 Unsystematic risk, 295 Untested technology, 922 Unused tax shields, 603–605 U.S coupon payments See Semiannual U.S coupon payments U.S federal taxation rates, 108–118 U.S markets, 36–37 U.S taxation law, 108 U.S Treasury bills (T-bills), 28, 710 bond, purchase, 268 debt issuer, 69 securities See Zero-coupon Treasury securities spot rates, 73 U.S.-dollar-denominated debt, 851 Useful life, 360 Valuation allowance, 111 Valuation equation See Basic valuation equation Value Line information, 788 Value Line Investment Survey, 343, 791, 798 Van Arsdell, Paul M, 937 Vardharaj, Raman, 300 Variable costs, 261 margin, 652 Variance square root, 279 standard deviation, interaction, 279–281 Variation, coefficient, 460, 592 See also Cash flow risk Index Variation margin, 86 Vaughan, Mark D., 702 VBernard, Victor, 792 Vendor leases, 895 Visibility, increase, 843 Volatility See Cash flow; Common stock estimation, 475, 476 Voting See Cumulative voting; Preferred stock rights, 534, 539–541 See also Contingent voting rights WACC See Weighted average cost of capital Walkling, Ralph A., 545 Wal-Mart Stores, Inc., 130, 803 activity, 760–761 Annual Report, 804 book value, 136 business, 754 cash flow, 141 common size analysis, 762–763 companies, opening, 827 economy, 755–756 example (1996-2001) See Financial ratio analysis financial analysis, integrative example, 754–764 financial leverage, 761–762 financial ratios, 756–763 industry, 754–755 liquidity, 758–759 operating costs, 759 profitability, 759–760 return, 757–758 warehouses, investment, 935 Walt Disney Company, 130, 753, 946, 947 Annual Report (2001), 121, 750 cash flow, 141 forecasts (1999), 784 Ward, Terry J., 816 Warehouse loan See Field warehouse loan; Public warehouse loan Warner, Jerold B., 610 Warrant, 248, 520, 542 See also Detachable warrant; Perpetual warrants life, 521 usage See Bonds Watts, Stephanie A., 777 WCC See Weighted cost of capital Wealth maximization See Shareholders Weighted average cost of capital (WACC), 326– 327, 479 Weighted average number of shares outstanding, 781 1007 Weighted cost of capital (WCC), 326–327 What if scenario, 462 Williams 5&10 expansion, 380–385 integrative example See Capital budgeting Williams, John Burr, 215 Woolridge, J Randall, 555 Working assets, 128 Working capital, 356, 627, 679, 729 See also Net working capital; Permanent working capital; Temporary working capital change, 374–377, 384, 808–809 concept, 799 conservation, 889, 913 increase, 376 management, 798, 849–850 needs, 391 Worldcom, 777 W.T Grant, 815 Yahoo! Finance, 343, 754, 784 Yankee CDs, 29 Yield See Annual yield; Bond-equivalent yield; Capital; Dividends; Earnings calculation, 67 change See Bonds definition, 31 interaction See Interest rates relationship See Coupon rate Yield curve, 72 spread, 71 Yield-to-call, 243–245 Yield-to-maturity, 231–232, 243–245 calculation, 233–234, 237–238 change, 241 contrast See Annual yield definition, 312 Zacks, analyst forecast, 784 Zacks Investment Research, 788 ZBA See Zero-balance account Zero-balance account (ZBA), 645 Zero-coupon bonds, 227, 234, 237–238, 498–499 return, 236 structure, 513 usage, 513–514 Zero-coupon debt, 31 Zero-coupon notes, 227 Zero-coupon securities, 73 Zero-coupon Treasury securities, 75 Zweignierderlassung, 833 ... instruments include: (1 ) options, (2 ) futures/ forwards, (3 ) swaps, and (4 ) caps and floors In Chapter we will discuss these derivative instruments What is important to understand is that derivative... than two of the following characteristics: (1 ) limited liability, (2 ) centralized management, (3 ) free transferability of ownership interests, and (4 ) continuity of life If the company has more... of that borrower Debt securities include (1 ) bonds, (2 ) notes, (3 ) medium-term notes, and (4 ) asset-backed securities The distinction between a bond and a note has to with the number of years